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ELSS schemes over a period of time will lose their charm and attractiveness because next Budget or the Budget after that, tax incentives will probably be entirely withdrawn. So then it does not make sense to have a lock-in period for your investments and I think equity as a general category can be looked at rather than ELSS as a specific category.
Does it impact your business in any way?
ELSS for the industry, is only 11 per cent of the total equity assets, which have built up over a period of time. ELSS served utility value all these years as a first-time investment. because of the tax break. Customers got used to the equity market. We have seen that those who came in through the ELSS have now diversified to regular multicap or largecap funds. So I think it has served a purpose of making equity as an attractive investment option in its early days.
What is the impact from dividend now being taxed in the hands of recipients?
I think essentially the impact is more from the removal of the DDT and taxing it in the hands of the investor. A significant proportion of investors have been investing in equity funds as a regular dividend option, and I think that they will need to re-evaluate this based on which tax bracket they are and naturally at the higher tax bracket it does not make sense to be in dividend option. You then look at the growth option or use the systematic withdrawal facility, which is available in most mutual funds to generate regular income from that thing rather than use dividend. I think dividend as a tool will probably be now less useful to investors.
Talking about the market, key domestic events are out of the way. Which is one dominant theme that will play out in the market over the next one year?
The key dominant theme will be two aspects; the recent rise in food inflation combined with a good rabi harvest expectation should have rural money cash flows being high in the hands of rural customers and their confidence in purchasing would be high as well. So I expect that discretionary consumption story, which has seen a little bit of a lull should be reviving. The second aspect is with the DDT going away. I think FDI, which was already given a lower tax incentive of 17 per cent in the last pre-budget announcement by the finance minister, with DDT going away, FDI will become even more attractive. So we could see the kick starting of the fresh manufacturing revolution. Make in India would get a thrust. Over the next year, we would start to see announcements from foreign manufacturers about opening shops in India, which will take time to translate in ground reality, but those would give a sense of optimism to the market about the future of Indian economy.
And how is the differentiation between largecaps, smallcaps and midcaps. Which space is more attractive?
All three have to be a part of an investor’s portfolio. I would not advise them to stick to any one asset class within large, mid and small. The reason I say that is while largecaps have the benefit of ETF flows and FII flows largely going into largecaps as a support to them, midcap and smallcap have the ability to deliver superior earnings growth when an economy gets into revival mode.
Since today we are in an economy, which has seen a slowdown, but in our estimate it is closer now to recovery and the lot of green shoots available, mid and smallcaps should be able to deliver better EPS growth and hence better earnings over the medium term. That being said, because the liquidity there is limited to a few domestic investors who put in money, there would also tend to be volatility in those flows. I would say a good healthy asset mix, which can be achieved through a multicap fund should be the first port of call for an equity investor because the fund manager would take a very judgemental call on how much should I increase my smallcap, midcap rather than the investor doing that at his level.
As a fund house if you were to hunt for value currently, would it be in largecap, smallcap or midcap space?
Rally in largecaps has been very polarised. Today you can find value in largecaps and midcaps and smallcaps because as you know the midcap index is trading at 11-12% discount to largecaps and the smallcap index is trading at 22% discount. So clearly while smallcaps and midcaps have a lot of value inherent in them, given the current valuations, I think even within the largecap space, the cyclical space is still at a discount to the broader largecap market. So I think you can find value across the cap curve.
Which sectors do you think will perform well over the next one year?
We expect a revival of the consumption story. So I think consumer discretionary — where people having more money would tend to upgrade to larger cars, larger houses, larger things is a key story for us. Second, is the cyclical story as the announcements of the infrastructure, the government also will allocate a lot of money to infrastructure. FDI announcements will happen. We expect the capital goods sector to also improve in terms of valuations over the next one year. I think an allocation to consumer discretionary and cyclicals is going to be a way forward. Across both these sectors, we expect banks and good quality NBFCs to benefit from the need for financing.
What are your thoughts on the pharma sector given the coronavirus epidemic?
We have a favourable outlook towards domestic pharma. I think the China virus story is going to impact the API supply to some extent and so there could be some kind of a supply shortfall, which might lead to an increase in pharma product prices. Some companies might benefit from the higher price realisations on their existing stock . I think that the virus is a 3-4 month affair and so after that this supply disruption would settle. The story on the pharma side is essentially an international recovery story just like IT. As long as the international story recovery is pretty strong, we think that pharma will recover. Over the last 12-18 months we have been generally underweight pharma and more focussing on hospitals and healthcare, but gradually we are now seeing that with the world showing signs of recovery, we are getting to be a little more neutral towards the pharma sector. We would probably wait over the next three, six months to see whether we want to go overweight, right now we are more of a neutral-ish position.
What about the defensive pack, IT?
If you look at it from a perspective of the US, recovery again is a key factor for IT, and the second factor is that the currency is a key play in the IT sector. If FII flows in India are going to continue to be strong, the rupee could stabilise, then in that case IT would obviously not do as well. I think IT as a component of the defensive allocation will continue, but I would not expect it to be the outperformer in our pack in the next one year.
Lifeinsurers took a big hit after the Budget was announced. Clearly the exemption-based inflows would take a hit here. Life insurance was looking a very lucrative space largely from our interactions with fund managers and analysts. How does it look now with these budget provisions?
There is a marginal dent in terms of the fact to the extent of tax savings and such tax incentives being a reason to purchase would be there. However, we think in the longer term, the penetration of life insurance and insurance as an insurance product as opposed to the equity component in getting 80C taxations would get more importance. The companies will up their ante in an effort of marketing insurance as a safety net for people for their future. I think the longer story will continue to remain bullish on insurance as one of the service sectors, which would do well.
Which sectors are you not looking at?
With the rally becoming more broad based, I would generally not have any sector that will be very negative, but I would say that for the current year PSU banks given their merger situation and all of that it probably be wait and watch situation. Probably next year, we would relook at that PSU bank story. That is definitely one space that we are underweight on.
When we look at third quarter earnings, they have not been very pleasing. We have had a lot of disappointments if we look at Tata Steel, Mahindra & Mahindra etc. There have been plenty of disappointments largely. We keep talking that the much awaited earnings recovery is around the corner but is it really around the corner?
From a broader perspective, we see that a few of the headline numbers have been not as per expectation, but if you look at it over a quarter-on-quarter perspective we see a general improvement happening. I think what is being reflected in earnings is also the last quarter’s impact. We think in the coming quarters the market is going to read into the future. While earnings may take time to catch up, I think the market’s view that earnings will catch up would drive valuations up even in these kinds of sectors. We believe that by the end of the year the earnings should be back on track despite what happens in this quarter.
Quite a few fund houses have been focussing on ESG funds, do you plan to launch one going ahead and how important do you think ESG as a criteria is in investing or are Indian investors matured and ready for such a product?
We are still at the drawing board in terms of ESG as a thought process. So far, we have not internally found a value proposition from a wealth creation perspective. I think it is more of a marketing side story that if you are socially conscious, and hence would not like to finance those companies which are socially hurtful. It is more from a marketing of allocating funds, but we have not yet seen evidence that such an event will deliver superior wealth creation to the customer. But, it is a constant study and at this point in time we do not have plans to launch a fund but if our research show up a wealth creation filter in this we will definitely look at launching it.
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